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In brief

    • What to expect in 2016?
    • Is it time to go back to basics?
    • Key strategies to help achieve real returns
    • Part 3 of the ESG series: Unconventional gas and a low carbon economy

What to expect in 2016?

DR SHANE OLIVER Head of Investment Strategy and Chief Economist Multi-Asset Group

As 2015 has come to a close, it’s now time when investors typically reflect on their positions – perhaps learning from market and subsequent investment performance throughout the year – and strategise for the New Year.

Have markets been good this year?

Last year we’ve seen constrained market conditions, which for most investors mean returns have not reached levels seen in previous years. However, there has been good news for those with money invested in international shares on an unhedged basis; they benefited from gains in European and Japanese shares, and in the fall of the Australian dollar. Overall, unlisted assets such as infrastructure and commercial property provided better returns than share markets.

Implications of the RBA interest rate hold

As the economy continues to rebalance in the wake of the mining downturn, The Reserve Bank of Australia’s (RBA) decision to hold interest rates this month has not come as a surprise. For 2016 the risks on rates are all skewed to the downside – it will be very hard to see the RBA raising rates. The New Year is expected to bring more of the same in terms of constrained growth in Australia and globally. That is, constrained but gradual growth. This is because conditions for a downturn or conversely, for a surge in growth, aren’t in place. Investors holding a balanced portfolio can expect a return of around 7.5 to 8%.

Is it time to go back to basics?

DEBBIE ALLISTON Head of Multi-Asset portfolio management Multi-Asset Group

We expect 2015 to mark the fourth consecutive year of positive performance in equity markets. But in a low-growth environment, investors are wondering just how much longer this equity run can continue. So in this environment, what should investors be doing? In a way it’s back to basics. There are two known ‘knowns’ in investing – the equity risk premium (ERP) and portfolio returns benefit from diversification.

Equity risk premium

There is overwhelming data that tells us of a premium over cash and bonds from investing in equities. While over very long periods the excess return of shares over bonds has varied, since 1900 the realised ERP has averaged more than 4.5% for the US and close to 6.0% for Australia. We are mindful of starting point biases and it is our assessment that the appropriate equity risk premium going forward, for developed market equities, is somewhere between 3.5% and 4%. For Asian and emerging market shares

it is slightly higher – between 4.5% and 5.0% – reflecting greater volatility. With cash rates and bond yields likely to remain low, and even with single digit equity market returns, investors will continue to be compensated for risk and equities should remain an asset class of choice.

Diversification

Diversification is all about trying to diversify away from equity risk, which is typically the biggest risk in most portfolios. The most obvious diversifier comes from investing in government bonds. In the event that economic growth falls, typically you see cash rates lowered, which reduces bond yields and increases capital value. The longer the maturity or duration of the bond, the more price-sensitive it is to changes in the bond yield. Despite the current low level of yields, bonds will outperform equities in the event of a significant correction, providing some offset to losses.

“Investors will continue to be compensated for risk and equities should remain an asset class of choice.”

Portfolio construction to maximise returns

In the current environment, investors should be evaluating the level of diversification across investments/ portfolios. Portfolio construction is a specialised skill that can maximise investors’ returns – even in challenging markets.

Key strategies to help achieve real returns

MATTHEW HOPKINS Senior Portfolio manager, Multi-Asset Group

The investment environment today is dominated by two themes – rock bottom bond yields and seemingly permanent sluggish growth. Regardless of what one believes about the future, it is likely that diversified investment returns are going to be lower over the next few years than what they have averaged over the last couple of decades. Lower starting point yields are evidence of this.

What can portfolio managers do to help generate real returns?

We believe there are three key areas where portfolio managers can materially improve the potential for superior return outcomes.

        • Increase flexibility of asset allocation – adopting a more dynamic process to respond to changing
        • Search for other return sources to introduce greater
        • Be What can investors do?

Given the outlook for returns over the medium term, investors – particularly those in or nearing retirement

– can take steps to help ensure their investment portfolio seeks to deliver the real returns they need to support their retirement income.

        • Have reasonable return
        • Potentially be prepared to take more risk in order to receive higher
        • Ensure investments are
        • Look for investments that are flexible in their approach and are actively

“It is likely that diversified investment returns are going to be lower over the next few years than what they have averaged over the last couple of decades.”

More information

If you would like to know more about AMP Capital’s goals-based approach to investing, please visit ampcapital.com.au/goals. 

Part 3 of the ESG series: Unconventional gas and a low carbon economy

IAN WOODS Head of Environmental, Social and Governance Investment Research

While the unconventional gas industry can provide a significant economic benefit to rural and regional areas, there are environmental and social issues that must be addressed.

Some of the environmental issues relating to unconventional gas include:

> Groundwater disposal – dewatering of coal seams to facilitate the production of coal seam gas can create a significant amount of groundwater which needs to be disposed of.

> Impact on systems and resources – levels and quality of groundwater should be comprehensively monitored during and after coal seam gas operations.

> The use of high quality water – in areas where water is scarce or in high demand, there is a growing expectation that fracking should use poorer quality water and collect and reuse flow back water.

> The use of chemicals – Australian companies have committed to disclosing when chemicals are used and to not use the potential carcinogen, BTEX, in fracking operations.

Social issues relating to unconventional gas

Much of the development of unconventional gas, and in particular coal seam gas in Australia, has occurred in areas that have had either little or no association with the oil and gas industry. This has caused conflicts in land use and changes to local communities. While these changes may have benefitted some, for others they have caused economic and social problems.

It is critical that the planning and approval process is transparent, open and comprehensive.”  Finding a way forward

It is inevitable that as the unconventional gas industry develops, it will change the nature and character of some areas. The planning and approval process should balance the potential costs and benefits that may accrue at a local, regional and national level. It is also critical that the planning and approval process is transparent, open and comprehensive to enable all stakeholders to participate.

Economic indicators
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Exchange rates
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Share market analysis
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*Data is most current available
**Rates are expressed as 1 Australian Dollar (IMF/OECD) purchasing-power-parity
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. © Copyright 2015 AMP Capital Investors Limited. All rights reserved.

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